Sunday, 18 November 2012

Philip Fisher on Bonds

Philip Fisher is most famous for his stock picking ability, especially in growth companies; most of his book "Common Stocks and Uncommon Profits" is also on the subject of picking enterprises with long-term growth prospects. However, I find his views on debt/bond investing extremely interesting and they should be on every long term investor's mind.The following blurb is from the end of chapter 1:

"As already explained, our laws, and more importantly our accepted beliefs of what should be done in a depression, make one of two courses seem inevitable. Either business will remain good, in which event outstanding stocks will continue to out-perform bonds, or a significant recession will occur. If this happens, bonds should temporarily out-perform the best stocks, but a train of major deficit-producing actions will then be triggered that will cause another major decline in the true purchasing power of bond-type investments. It is almost certain that a depression will produce further major inflation; the extreme difficulty of determining when in such a disturbing period bonds should be sold makes me believe that securities of this type are, in our complex economy, primarily suited either to banks, insurance companies and other institutions that have dollar obligations to offset against them, or to individuals with short-term objectives. They do not provide for sufficient gain to the long-term investor to offset this probability of further depreciation in purchasing power."

Mind you these views were written in the late 1950's when inflation and interest rates were drastically different so lets note some fundamental changes that have happened since and see if his views still apply.

1. Central bankers, even of developed nations were yet to gain credibility on their ability to control inflation. Inflation has been under control for developed markets for the most part since early 1980's.

Although inflation levels are low despite the easing efforts of central bankers, bond yields are not providing much margin for real returns. Investors currently purchasing 10 year government securities are locking in 2% annual return and 0% real return at the current level of inflation. Obviously investors in such securities are still individuals with short-term objectives hoping for another short-term reduction in yields. The risk of higher inflation is obviously still real.

2. Some could argue that recessions have become longer or more severe, especially considering two decades of persistent deflation in Japan and the Great Recession of 2008.

This point is a bit tougher to address since I'm not an expert on the Japanese bust or an economist. I'm not sure of the role that fiscal and monetary policy decisions have played in the Japanese economy but it is clear that other major economies are not suffering from the same problems or policies. Growth has been positive in most developed and developing nations since 2009 with the exception of a few European economies. The credit expansion leading up to the 2008 burst has certainly made it tougher to re-inflate economies out of the slowdown. However even during these extremely tough conditions with many overhangs on individuals and businesses, growth has managed to crawl back to the positive range.

3. Austerity (fiscal restraint) is being considered in many European nations as an alternative method of dealing with recessions.

I suppose this is the one change that if it does start to receive broad support from central bankers, could nullify most of the factors that make bonds unattractive as long-term investments. Two key results of such policies would include 1) corporate profits will suffer from longer periods of negative profit growth, meaning the bust period of the business cycle will be longer 2) no persistent budget deficit that needs inflation, meaning if bond yields offer high enough yields, they could be realized as decent real returns.

Obviously even with persistent deflation or the adoption of austerity, a successful growth company will always outperform bonds; picking growth businesses in such an environment could be much tougher though.

No comments:

Post a Comment